subprime, "freeze!"

[feihong]

The US government has made a critical decision in pushing to have the subprime mortgage rate frozen for the next 5 yrs to reduce foreclosure rate. The million dollar question is, will people still walk away from their own properties (since the value has dropped so much that it's not worth paying interest) and will they see this opportunity to spend the money on luxurious xmas gifts and holiday again?

http://www.bloomberg.com/apps/news?pid=20601087&sid=asetzdsdmBUE&refer=home

 

[lizzie]

so - is that just delaying the inevitable by 5 years, when interest rates will then spring up? or are they hoping that people will have spent the 5 years planning for the increase?

alexlee - laaussie - thoughts?

 

[BayView]

Well, human nature being what it is...

The people who are in that (sub-prime) predicament are either bad with money, or trying to trade up to a house that they really can't afford, or both. It would be interesting to know how many $200k plus income earners are in this mess.

Also, quite often these people are consumers and have consumer debt.

My guess is that if the Govt steps in to save them via a freeze on the rates so that they don't walk away from the commitment, then they'll just go back to their same old habits:-

"You bewdy; now we can keep our house thanks to G.W! Let's go and celebrate - I always wanted to go to Hawaii! Where's the credit card; there's a great deal on Orbitz this week!"

These people don't plan past next week, so I reckon it will delay the inevitable.

 

[alexlee]

There are two main possibilities. People see the rate freeze as a reprieve and instead spend money on more plasmas, and the economy recovers its strength (but doesn't work out all the excesses built up during the bubble).

The other is that homeowners instead use this time to batten down the hatches, and try to pay off their debts and maybe even sell their properties as the market flattens.

I think the latter, because homeowners (especially the fringe ones) are scared. They've finally realised property doesn't go up in a straight line, and there is a LOT of oversupply in the US.

In short, I think the downturn in property and the US economy will continue, but there is less chance it'll just rush off a cliff.

There is a possibility that this will turn into a limbo economy where the market just trends down for years, instead of taking some sharp pain now. I'm surprised the yanks are doing this sort of direct market intervention. But then housing is very different from the sharemarket.
Alex

 

[lizzie]

how do you guys think i will affect australia? i have my opinion - but then again, i'm an eternal optimist so won't view it here.

 

[trendsta]

Wow.. now I have seen everything. China becoming captalist with its policies and US becoming communist style with its policies.. Isnt the objective of captalism ‘efficient’ allocation of resources, the main one being capital/money, and inefficency is eliminated over time by ‘bad’ capital and excessive risk being punished thru detoriarated returns??

Imagine govt implementing such a policy for tech stocks in 2000/01.. “anyone with a margin call can keep their shares for 5 years and then the margin call will apply”.. yippie .. what would the impact have been ??
Anyways, enough of the theories and logic..

Im as confused as the next person, or even more so now. The only small negative I see is potentially for the investors of these loans. If u based ur profit projections based on mortgage rates rising you could be in bit of trouble. But, i suppose better to get lower return than no return .. so maybe everone wins? Maybe everything is fine and rosy …

Hmm… lower mortageg rates = more money available to spend or reduce debt. If its spent consumer spending goes up, reduce debt and mortageg companies will simply apply the fractional banking and push the money back to new debtors. Add to that cheaper credit (US reducing rates) .. so in summary looks like more money all around .. woohoo ..

So the other negative may be higher inflation .. more money spent on consumer goods, which are mostly imported, or on assets that are non-productive must cause inflation … but then again im going to theory and logic again .. must stop doing that ..

must start to listen to the mass-media and US govt.. there is no inflation, economy is fine, sub-prime is over – golden age continues..

 

[alexlee]

Hmm… lower mortageg rates = more money available to spend or reduce debt. If its spent consumer spending goes up, reduce debt and mortageg companies will simply apply the fractional banking and push the money back to new debtors. Add to that cheaper credit (US reducing rates) .. so in summary looks like more money all around .. woohoo ..

This is the part I believe will lessen the effectiveness of freezing mortgage rates. The banks are smarting from subprime losses. Freezing rates helps because it’ll hold a lot of mortgage defaults (you hope), but that doesn’t mean the banks will lend more. If anything they’re just going to use this opportunity to shore up their balance sheets.

In the last couple of years the banks lent out too much. They’re not going to go back to that for a while.
Alex

 

[yieldmatters]

This is the part I believe will lessen the effectiveness of freezing mortgage rates. The banks are smarting from subprime losses. Freezing rates helps because it’ll hold a lot of mortgage defaults (you hope), but that doesn’t mean the banks will lend more. If anything they’re just going to use this opportunity to shore up their balance sheets.

In the last couple of years the banks lent out too much. They’re not going to go back to that for a while.
Alex

Wouldn't the freeze collapse their balance sheet even further as the debt is now worth less? (i.e. lower interest rate - worth less money). Or is the government (the public) chipping in the difference.

 

[alexlee]

Wouldn't the freeze collapse their balance sheet even further as the debt is now worth less? (i.e. lower interest rate - worth less money). Or is the government (the public) chipping in the difference.

The main risks with the banks right now is that further defaults will make their CDOs decline further in value. An interest rate freeze will presumably decrease defaults which will slow down the deterioration of the CDOs.

Lower interest rates will affect profits, but not the value of the mortgages that the banks hold because that's more driven by defaults as opposed to income.
Alex

 

[tubs]

WOW! That's HUGE news. I can't believe it, and wont until I actually hear it officially announced.

It means the US Govt is deciding to artificially prop up their economy, which I think is a sign that they're really worried. I think the market should always be allowed to sort itself out. It's like water. It'll find its own level soon enough anyway.

I dont understand how they can. The borrowers have an agreement with the lenders, and so the lenders are missing out on millions and millions (and millions) of repayments. Who is going to reimburse them?

And why do the US Govt feel they have the right to overturn these agreements, which the borrowers signed and agreed to! That's not only highly irregular, but on such as massive scale...unprecedented!

This is probably driven by the managed funds, who stand to lose billions if their RBMSs (Residential Backed Mortgage Securities) are downgraded again.

 

[alexlee]

It means the US Govt is deciding to artificially prop up their economy, which I think is a sign that they're really worried. I think the market should always be allowed to sort itself out. It's like water. It'll find its own level soon enough anyway.

Yes, but the questions is what level is it at? And you can't dismiss the timing: elections are coming up.

I dont understand how they can. The borrowers have an agreement with the lenders, and so the lenders are missing out on millions and millions (and millions) of repayments. Who is going to reimburse them?

They don't have the legal right, but they can influence the banks into agreeing to it. Sort of like the Long Term Capital Management bailout. The Fed just browbeat the banks into bailing it out. I suppose the banks could justify it by saying 'we would have lost more had foreclosures increased'.

And why do the US Govt feel they have the right to overturn these agreements, which the borrowers signed and agreed to! That's not only highly irregular, but on such as massive scale...unprecedented!

Because they fear a cascading recession. It does seem very heavy handed. It's an admission that the usual methods (e.g. cutting interest rates) doesn't work or has bad side effects.

This is probably driven by the managed funds, who stand to lose billions if their RBMSs (Residential Backed Mortgage Securities) are downgraded again.

Bit of both. It's also driven by the election. Who wants to face a bunch of voters after the country goes to hell? Paulson must be influenced by his Goldman buddies, too.

BTW it's not all loans, just a portion of them. Haven't read all the details yet: the New York Times download is in my computer now.
Alex

 

[yieldmatters]

The main risks with the banks right now is that further defaults will make their CDOs decline further in value. An interest rate freeze will presumably decrease defaults which will slow down the deterioration of the CDOs.

Lower interest rates will affect profits, but not the value of the mortgages that the banks hold because that's more driven by defaults as opposed to income.
Alex

I don't know Alex - there is something I'm missing here.

Lets say I'm a bank and somebody owes me $150,000. That debt sits on my balance sheet as an asset worth $150,000 plus the expected interest adjusted for a probability of default (all discounted to present value). This action (freezing rates) reduces the probability of default (in theory - but that is another post) but it also reduces the expected interest received. Unless the govt is chipping in the difference on the interest?

I will have to investigate it further.

 

[alexlee]

Lets say I'm a bank and somebody owes me $150,000. That debt sits on my balance sheet as an asset worth $150,000 plus the expected interest adjusted for a probability of default (all discounted to present value). This action (freezing rates) reduces the probability of default (in theory - but that is another post) but it also reduces the expected interest received. Unless the govt is chipping in the difference on the interest?

I will have to investigate it further.

Loans aren't discounted to present value when presented on the books, as far as I know. That's why banks will take an earnings hit in terms of interest revenue, but the value of the asset is not affected by the interest rate. You lend out $150k, it's a $150k asset on your books unless the borrower defaults.
Alex

 

[yieldmatters]

Loans aren't discounted to present value when presented on the books, as far as I know. That's why banks will take an earnings hit in terms of interest revenue, but the value of the asset is not affected by the interest rate. You lend out $150k, it's a $150k asset on your books unless the borrower defaults.
Alex

OK - I'm with you. That makes sense under historical cost.

But if it is a CDO that is marked to market then the carrying value on the balance sheet must be somewhat related to the earnings the asset can generate in the future (i.e. interest income). So it's an interesting one.

On a side note I think they will still default. If you just have to hand in your keys to clear the debt and you are in negative equity then why wouldn't you do it?

 

[grossreal]

hi all
its good that the us are chipping into help but a couple of questions.
will this cover the liar and arm loans that have not opened yet.
the banks usually have a lvr but by freezing the loan in a falling market you are saying that I won't move in for 5 years in an area that already looks like a battle field a property that as on the books at say 150 is worth in the market today of 75 at best.
so there lvr will be over 100% and they are saying that we will have them oin our books for 5 years without knowing what that lvr will be ???
the us is in for a correction with or with out this and for the banks to hold these loans will be very interesting to see and is going to be a very big stick to make them do it.
most of the liar loan people got there because they have no income alot have or will be stripped.
in 5 years you have a property in a corrected market thats well above 100% lvr( they are above that now alot of them, as the market has already fallen)
with no income.
I would no like to take that to the next gm
interesting times

 

[alexlee]

But if it is a CDO that is marked to market then the carrying value on the balance sheet must be somewhat related to the earnings the asset can generate in the future (i.e. interest income). So it's an interesting one.

I'm guessing here but while CDO values will be affected by lower interest rates, it will be offset by lower default assumptions (remember CDOs are very illiquid things so the value is still model-determined). That's what Paulson will be selling to the Street, anyway.

On a side note I think they will still default. If you just have to hand in your keys to clear the debt and you are in negative equity then why wouldn't you do it?

Details are still coming out but it seems to counter the moral hazard, the plan is to only modify resetting ARMS where the borrower is current with their payments, and to only modify them if it is judged that the borrower can't pay the higher reset rates (nightmare to administer, though: expect finger pointing about fraud for years to come).

So, the plan won't help those already in default of even already behind in their mortgage. It's basically the theory of letting the weakest patients die and giving drugs to those that have the disease but aren't showing the symptoms yet.

It'll prevent SOME defaults, but certainly not all. And one wonders whether it'll just delay it.
Alex

 

[s_t]

Interesting article here
http://blogs.marketwatch.com/greenberg/2007/12/straight-talk-on-the-mortgage-mess-from-an-insider/

if I read it right, some lenders are preventing further withdrawals from open/approved LOC's?

 

[grossreal]

hi all
with regards to this mutted freeze as per the fin today they are still doing the loans not as much but are still doing this form of lending and swiss are in there as the biggest this month.
so does this freeze include those so it could be seen as a defacto cheap fixed rate loan.
if you had a arm that started at 4.5% then 5.5 the 6.5 the 7.5 the 8.5 the 9.5 and then the balloon if you had it at the 4.5% and the bfreeze comes on you are locked at 4.5% for 5 years thats not a bad deal.
something does sound right.
the have said that the cdo trades are lower this month( they didn't say that they are not available)
anyone going to have a bash to get this loan.

 

[spark]

WOW! That's HUGE news. I can't believe it, and wont until I actually hear it officially announced.

It means the US Govt is deciding to artificially prop up their economy, which I think is a sign that they're really worried. I think the market should always be allowed to sort itself out. It's like water. It'll find its own level soon enough anyway.

I dont understand how they can. The borrowers have an agreement with the lenders, and so the lenders are missing out on millions and millions (and millions) of repayments. Who is going to reimburse them?

And why do the US Govt feel they have the right to overturn these agreements, which the borrowers signed and agreed to! That's not only highly irregular, but on such as massive scale...unprecedented!

This is probably driven by the managed funds, who stand to lose billions if their RBMSs (Residential Backed Mortgage Securities) are downgraded again.

Some points to notice:
1) Freezing - at whose expense? The banks profits? Why then their shares are going up?
2) The act is mainly symbolic - comes directly from GWB, but affects less than 10% of borrowers. What is going to happen to the remaining 90%?
3) Reading the Bloomberg article (from the link above) I understand that the criteria for the arranged help is for people with really low credit scoring. Even if it will help them to continue somehow, who will help the majority (the middle class) above?
4) Suppose you get such help - do you keep the house in a declining market or sell it? Isn't it postponing the problem to constantly loom above the future?

My hunches:
1) The sub prime problem is perceived to be really serious in size and in consequences - that's why they need GWB personally to announce the plan. You learn it even by the sheer fact of an (attempted) intervention in the free market!
2) Problem is insolvable - Media declarations by the president himself and treatment (even if successful) of 10% of the resetting loans, leaves the other 90% in trouble.

 

[MissMuffitt]

Sub prime "freeze" very selective about who it will help!
http://money.cnn.com/2007/12/08/real_estate/Bush_plan_limitations/index.htm?postversion=2007120909